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July 3, 2012

Why a Floating NAV for Money Market Funds Is a Bad Idea

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SEC Chairman Mary Schapiro’s recent testimony before the Senate Banking Committee about scrapping the $1 per share stable net asset value (NAV) for money market funds made me wonder: if every American had to declare a taxable event every time we withdrew money from an ATM, wrote a check or swiped a debit card, would we still feel comfortable leaving our money on deposit at a bank?

The answer, of course, is no. The paperwork alone would make the thought of going to an ATM more painful than a trip to the dentist. Many would feel that keeping their money on deposit at a bank was no longer worth the hassle—and the consequences for businesses, investors and the economy overall would be severe.

This scenario may sound far-fetched, but Chairman Schapiro’s recent suggestion that the value of money market mutual funds should be required to float according to the fluctuations of the market could force American investors to ask similar questions about a critical component of their investment strategies. And just as in my earlier analogy, the consequences for both individuals and businesses could be severe.

At FSI, we are acutely aware of the importance of money market mutual funds to Main Street American investors, since these are the clients our financial advisor members serve every day. These investors look to money market funds for liquidity, diversification and convenience, along with a market-based yield. These individuals, as well as businesses and institutions, make broad use of money market funds to hold excess cash for short periods of time and to maximize liquidity.

The stable NAV is central to these benefits. Investors purchase and redeem millions of dollars in money market fund shares every day. With a stable NAV, those investors are relieved of the burden of tracking gains or losses for tax or financial accounting purposes.

With a floating NAV, however, every money-market sale would be a tax-reportable event, substantially increasing tax and record-keeping burdens and significantly reducing the benefits of money market funds to Main Street investors.

By forcing money market funds to use a floating NAV, the SEC could inadvertently hobble individuals’ and businesses’ cash management capabilities and drive up the cost of investing and doing business by imposing new record-keeping and tax reporting requirements for any entity that invests in these funds.

Money market funds also play a crucial role as an intermediary between individual investors and businesses with short-term financing needs. Money market funds hold more than one-third of the commercial paper that businesses use to meet short-term operating obligations, such as funding payrolls, replenishing inventories and financing expansion. If individual investors no longer view money market funds as a viable and liquid repository for short-term funds, the flow of capital to businesses will be significantly disrupted.

Few immediate substitutes are available to fill the financing gap that would be created by a rapid shrinkage of money market funds. Even if banks could raise the new capital needed to meet demand, the lending market would be less efficient and costs would rise. Alternative funds are less regulated, less secure and less liquid.

Moreover, money market funds play a crucial role in financing state and local governments, since as mutual funds they are able to pass the benefits of tax-exempt income along to investors. Tax-exempt money market funds currently hold more than half of the short-term securities issued by state and local governments. By making money market funds less attractive to investors, then, the SEC could create another barrier for municipal governments seeking to raise money for basic operations in a difficult environment.

FSI understands the SEC’s desire to protect investors and strengthen America’s regulatory framework. Imposing a floating NAV on money market funds, however, is simply not in the best interests of American investors or businesses; rather, this measure could unnecessarily undermine one of the key instruments that Main Street investors count on for stability and liquidity, while depriving businesses and governments of a crucial source of financing.